Just as with personal credit, business credit helps suppliers, lenders, and other creditors quickly determine whether a business pays its bills on-time. As a business owner, you will want to put your company in a position to where it can secure whatever financing it may need. This means you will have to establish, build, and maintain your company's credit profile.
Legally Form Your Business
Before you can establish business credit, you will need to legally form your company as either a corporation, limited liability company, or a partnership. You can do this by either working with an attorney or by filing the necessary paperwork directly with the state you'll be operating in. The rules and requirements are different for each state and the structure of your business will depend on your specific needs such as tax preferences.
Obtain Federal Employment Identification Number or EIN
Just as each individual has a social security number, every business must have an employment identification number. This number is how the IRS will identify your business for tax purposes. It is also the number you'll use to open a business checking account, apply for credit, and to establish and build your business's credit profile. Your EIN is free and you can request it from the IRS online after you have legally formed your company.
Open a Bank Account
Your business should have its own bank account that is separate from all of your personal accounts. The bank will need your company's EIN, phone number, and physical address to open your account. Most lenders like to see an account history of at least two years, so open your business account as soon as possible.
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List Your Business in Directories
Listing your business in all the popular directories will help it look legitimate in the eyes of both customers and lenders. The only things you'll need is a phone number, physical address, short description of your company, and a couple of pictures.
Create a Profile with a Business Credit Bureau
This is one of the most important steps towards building business credit. Without a profile, your business would be practically invisible to lenders. Business credit bureaus operate similar to personal credit bureaus except their products and services are tailored specifically to take care of the unique world of business lending. After you have created your profile, you'll want to manage it closely just like you would your personal profile to ensure it is accurate and up-to-date.
Importance of Business Credit
Now that you have established a credit profile, you can start taking steps toward building creditworthiness. Here's a short story that illustrates how important good business credit is: One year after launching his bottling business, Trevor Jacobs started leasing a facility and, consequently, he was in the market for larger, more efficient equipment. He had a $5,000 limit on a business credit card, but he would need hundreds of thousands of dollars to purchase the equipment needed grow his business as fast as he envisioned.
He figured he could easily get a loan since his business was taking in $3.8 million in annual revenue. He was surprised, however, when every bank turned him down. "At the time, I didn't understand why," says Trevor. "They just said no." He shrugged it off as just the plight of a young business. The real reason was because he failed to establish and build business credit early. While banks consider revenue, it means nothing to them if you don't have a history of paying people back.
Later that same year, Trevor met a venture capitalist who offered $570,000 for a 25 percent stake in his business. In addition, he guaranteed a $800,000 credit line. Today, Trevor's business brings in approximately $24 million in annual revenue and has 41 employees. He is now contacted regularly by banks offering loans and credit lines. The funny part is that he doesn't need it anymore. Obtaining credit always seems easier when you don't need it. The good news is that there are ways you can avoid facing the same rejection.
Apply for Starter Accounts
One of the easiest ways to build credit as a new business is to apply for credit with your vendors and suppliers. Vendors and suppliers will extend credit to a business with a young credit history and they also offer some of the most relaxed terms. They are a great way to get your foot in the door. You can purchase office supplies, computers, and other materials that your business needs with net 30 or 60 day payment terms. Make sure that the supplier you choose reports to business credit bureaus. After about one year, you could start applying for store credit cards, unsecured credit cards, and eventually loans. The key is to pay everything you borrow back on-time. Late or missed payments will damage your credit score and will make it difficult to secure new financing.
Grow and Use Your Credit
Most companies that have outstanding business credit scores obtained and used business credit very early. In addition to starting early, you should request credit limit increases every three months even if you believe you won't need it right away. For items you would usually pay for with cash, use credit instead. Play the game, but don't purchase anything your business doesn't need.
Have Relationships with Several Financial Institutions
In business, it's never a good idea to put all of your eggs in one basket. Banks can change the terms of their loans or lower your credit limits at any time. You don't want these sudden changes to delay your current projects or stunt your growth potential. In addition, having several relationships will give you more leverage since the different banks would be fighting for your loyalty.
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How Business Credit Scores are Determined
Business credit scores range from a high risk of zero to a low risk of 100. Your score is determined by several different factors including:
- Account balances
- Payment history
- Credit utilization
- Trade experiences
- Public records
- Trends
- Length and age of credit
Every financial decision you make will put you a little closer to zero or 100. Because your business's credit report will constantly change, it's important to constantly monitor your profile for accuracy and completeness. You should know what creditors will see before they see it. Monitoring your company's credit profile will help you:
- See entries that could negatively affect your business
- Improve your business's credit score by knowing your strengths and weaknesses
- Know which creditors are inquiring about your company
- Prevent business identity theft and fraud
It is important for businesses to establish and start building business credit early. If you wait too long, you could be denied for loans and credit that your company desperately needs. The tips above will show you how to establish, build, and maintain your business's credit profile.
